Medifast: Perfect For Dividend-Growth Investors

Summary

• Medifast has great financials and a deep moat around its business.
• The company grew its quarterly dividend by almost 500% since 2016 and currently has a dividend yield of 3%.
• Due to a relatively low payout ratio and many growth opportunities, the dividend is expected to increase even further in the future.
• A conservative relative valuation of the stock reveals an upside of at least 50%.

Prostock-Studio/iStock via Getty Images

After a 40% price drop since May of this year, I believe Medifast (NYSE:MED) is currently undervalued and has an upside of at least 50%. Below I will analyze the company’s deep economic moat and its many growth opportunities. Also by taking a deeper look at Medifast's financials, I will show that the company, besides its rapidly growing revenues, has a very stable profit structure, a debt-free balance sheet, and a very investor-friendly management.

Company overview

Business model

Medifast sells diet-related food products under its Optavia brand. The company sells its products via its coaches who act as “micro-entrepreneurs”. Coaches contact potential customers, often friends or family and other social media contacts, to help them live a healthier lifestyle with the help of the company's subscription-based diet plans. For each sale, the coaches earn around 25% of the sales price as commission.

What I personally like is that the coaches don’t sell these kinds of “lose 20 pounds in one month” products, but instead try to help the clients to establish positive long-term diet changes. Obviously, the company’s idea behind that is to bind customers for longer than just one month and therefore increase the customer lifetime value.

The coaches usually don’t sell single products, but instead sell diet plan subscriptions which include breakfast, lunch, a snack, and dinner for 30 to 90 days. Monthly costs for these subscriptions are around $300-$500. I have read a few reviews about the products, and found that they seem quite average – there definitely is no competitive advantage from the product itself.

Multilevel Marketing (MLM)

Without a doubt, the whole company’s business is based on MLM. Such business models are obviously under scrutiny; however, Medifast does a really good job in making everything very professional and much less "shady" than most other MLM operations. Besides a redeemable $200 fee for new coaches, which is used for an individual website, and a starter pack that includes instructions for the coaches, there is no other down-payment needed for coaches. So coaches don’t have to buy e.g. a thousand pieces of healthy chocolate muffins, and then possibly never be able to sell them. By taking the risk away from the coaches, the company's business model has never faced any bigger problems.

90% of Medifast’s coaches are ex-customers who liked the product so much that they later joined the company as coaches as well. Therefore, Medifast has an enthusiastic workforce and at the same time doesn’t have to spend much money on recruiting, as the coaches recruit coaches themselves (just like in any other MLM, coaches who recruit other coaches, also get a small share of their newly hired coaches).

Based on the quickly increasing number of coaches and revenues, it seems like the concept is working and that the coaches are satisfied with the company. Quarterly average revenues per coach were $6,662 in the last quarter. This is obviously not a high number; however, we need to keep in mind that many coaches are only doing this part-time. Also, that number has been increasing quickly over the last few years as you can see in the picture below. I believe those numbers are proof that the business model of the company really works for its coaches.

Source: Investor Presentation August-October 2021

The beauty of MLM is that growth directly translates into more growth. If a coach finds more clients, more clients will turn into more coaches who again will find more clients. And the rising revenue per coach proves that this is still possible without coaches taking market share from each other. So, even if the pandemic might have helped sales, future sales will still benefit from it even after COVID is gone.

Growth opportunities

Many consumer and market trends will help Medifast grow even more over the next few years. The company estimates a 15% long-term growth rate.

Currently, the company makes a majority of its revenues in its home market, the US. Before the COVID pandemic, Medifast also wanted to bring Optavia to Asian markets, but their plans were cut short due to the emergence of COVID and were therefore not very successful yet. However, once we have arrived at a “new normal”, there will definitely be many more growth opportunities in Asia, Europe, Australia, and possibly South America.

Furthermore, in America 70% of the population is overweight, and the number of overweight people will increase at a rate of 2% every year. Combined with people trying to live a healthier lifestyle, going forward the company will further benefit from these positive macro trends.

And finally, compared to a decade ago nowadays more and more people are more willing to join the gig economy or to have a side business. This trend will continue with growth rates of 10-15% over the next few years. Therefore, Medifast will have a larger and larger pool of people who consider becoming coaches.

Competitive advantages

Through Medifast’s business model, the company was able to slowly make its moat deeper and deeper.

Firstly, the company has a very lean overhead structure. Despite generating almost $1B in sales in 2020, the company employed only 713 employees, of which 409 worked in manufacturing. Therefore, there are only 304 employees working in marketing, administration, and other central functions (coaches don’t count as employees). Moreover, from its coach-system, the company basically gets “free” marketing and has almost no recruitment costs as coaches also do this job for “free”. All these points combined give the company a big cost advantage over its competitors.

The close relationships between customers and coaches also tend to make customers more valuable in the long term. Even more so as the company sells month-long food subscriptions instead of single products. Also, Medifast is trying to build a community around the products, in which customers and coaches all interact with each other. All these points combined make customers even more loyal to Optavia.

Furthermore, Optavia’s brand is already well known and a growing brand will also give the whole MLM structure even more credibility.

Finally, the good brand and its coaching structure allow the company to sell its products directly to customers, without having to pay retail stores or e-commerce platforms. Over 90% of the company’s revenues are via direct sales. This is yet another cost advantage over competitors who have to pay retail stores, etc.

Financials

Revenue growth

For many years the company’s annual revenues stagnated around $300M. However, since 2018 the revenues started to grow rapidly, reaching $500M in 2018, $710M in 2019, and $930M in 2020. Below we can see that the revenues grew even faster in 2021, reaching quarterly sales of $394M in the second quarter.

Source: Author

Based on the company’s guidance from August this year, for the remaining two quarters the company expects sales of around $370M per quarter. This signals, a slowdown of quarter-over-quarter growth, but still is a big jump when comparing sales year over year.

As shown above, there are still many trends and growth opportunities that should ensure that the company keeps growing in the next few years.

Profitability

In 2021, the company expects earnings of around $13-14, giving the company a quite low PE ratio of around 14.5. Two other very positive points need to be mentioned about the company’s profits.

The first one is that MED has proven that with increasing revenues, the company is able to use its economies of scale to grow profits even more (absolute and relative). In the chart below you can see that on the back of increasing revenues, the profit margin has increased gradually over the years. This is a very positive sign, that shows that the company doesn’t just “buy” market share by using lower prices, but instead can profit from a higher market share.

Source: Investor Presentation August – October 2021

The second point to note is that the profits are very stable (also during all the years before 2018). The reason for that is that the cost structure is very variable. Only 13% of the operating costs (as a percentage of revenues) were fixed costs.

Source: Investor Presentation August – October 2021

The company’s low fixed costs ensure that even in the unlikely scenario of decreasing revenues, Medifast will still be profitable.

Balance sheet & use of profits

In a debt-heavy environment, Medifast stands out. The company has no debt at all on its balance sheet and can therefore show off its net-cash position of $192M.

The balance sheet doesn’t have many assets, as the business model is not very capital-intensive. The low cash need and an investor-friendly management have resulted in huge shareholder returns over the years. Since 2016 40% of the profits were paid out as dividends, currently giving the company a dividend yield of almost 3%. The quarterly dividend has increased by almost 500% since 2016 (from $0.25 in 2016 to now $1.42). The low payout ratio and increasing earnings give hope for further dividend raises.

The company also used around 25% of its profits to buy back shares. The remaining 35% stayed within the company, mostly to finance its rapid growth.

Valuation: 50% upside

By annualizing the EBIT from the first two quarters of the year, the company is currently trading at an EV/EBIT ratio of around 9.1.

Based on its peer's EV/EBIT multiples between 17 (food processing) and 22 (household goods), there is still a big upside for the company.

To stay conservative I will use the lower multiple (17) and use a 20% discount for Medifast’s business due to the risks that come from its MLM business structure, and I will completely ignore that the company will likely grow faster than its peers. With the resulting multiple of 13.6, the company would be valued at around $290 - an almost 50% upside from the current price. And just to stress this again, this is still a conservative estimation.

Bottom line

Medifast has a relatively deep moat around its business and grows rapidly. Combined with a solid balance sheet and an investor-friendly management, this stock likely is a great investment opportunity. The stock is especially interesting for dividend-growth-focused investors due to its quickly increasing 3% dividend yield and a relatively low payout ratio.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Guyelm]

If Herbalife's sellers will check from time to time how their customers doing and motivated them, they will be the same as OPTAVIA's coaches.
Herbalife brand is much bigger than OPTAVIA.

So.. why MED?

[EE Investing]

@Guyelm Both seem cheaply valued, but MED is growing faster. Every company has competitors, but that doesn't mean we shouldn't invest in them. Especially in this case, we saw over the last years that both companies are able to be profitable at the same time without hurting each other's business.

[Guyelm]

@EE Investing so there is no big moat here, there is a market that's need to be filled.
Let put the valuation aside, how the business named Medifast better than Herbalife? Can't find a pure competitive advantage here.

[dc_dwd]

@Guyelm their moat is their network of ~55,000 coaches, and growing every year. Business is growing organically, and they haven't penetrated a couple of the largest markets in the world like China and Latin America. You won't see this stock rip during this inflation environment because of the margin pressures, and investors are more interested in the reopening play. So, definitely a good time to buy if you're a long-term investor at his discount.

[Pillspillar]

Thanks for the nice write-up and great idea.

I would add that the tight share structure (low sharecount and virtually no dilution) make for an explosive upside once the market catches back up on the name. However I think this is true as well on the downside if the company underperformed.

[craftbrewinfo]

Saw the chuck carnevale video today, doing my own due dilligence and I really like what I see here !

[Gr1iev3r]

i went all-in here. it is the best stock, with the most favorable metrics i could found this year.

sold all my other positions. i will take a pill, going sleep, and when i wake up i will be happy :D

[mb1099]

Really strange stock. This is now the same price as it was on or about 8/1/18. Yet in 2021, the EPS will be triple what it was in 2018, and will grow further next year and beyond. Very rare and very strange. Not to mention you get a debt free company and a 3% yield.

[craftbrewinfo]

@mb1099 That's Mr. Market's irrationability at work

[B_Banzai]

My wife is a satisfied customer. The food is "so so", but when she stays on plan she does well. She lost 20 lb last year. Then the holidays came and she struggled to get back on track but finally is seeing her weight fall again. I imagine this is typically how things go. The products are not cheap, but they do work if you maintain discipline. I decide to get back into the stock.

[craftbrewinfo]

@B_Banzai so did my wife! those snack bars have been in the past to now, the only thing that ever knocked out her cravings to eat... she lost 25lbs in a little over 2 months.. it works.. Different from Weight watchers- they are just coaching, different from Nutrisystem, which is just food.. here you have the food and coaching

[mb1099]

A couple missing points in a great article and commentary board:

Management stated in the last earnings call that they are gearing up (via improved supply chains, logistics, and manufacturing capability) for a $2B run rate in sales sooner rather than later (my guess is '23). This is a pretty bold and specific statement, that certainly speaks to the company's optimism about Optavia and its continued growth trajectory. At that level of sales, we will see $20/share in EPS (at a minimum), which really makes this a screaming buy at a PE of under 10. So by simply ignoring the noise regarding inflationary impact on margins in the short term, we are bound to go much higher just based on meeting this target of $2B/yr in sales.

Let's not also forget that going on youtube or other social media and seeking out weight loss coaches or advocates is far easier said than done. An MED trained and incentivized coach that routinely checks in on and motivates the customer via tech driven applications specifically developed and refined by MED for that purpose is in fact a pretty decent moat. Granted anyone can be a 'health coach' but the Optavia business model in its totality works for the customer, the coaches, and the company. As long as the company keeps on chugging along this ridiculous share price will seem like a huge bargain.

[bionic1]

Down 42% since 6/1,continuing lower highs & lows.Looks like the share price is the only thing on a diet!!

[HardytheTrader]

$MED was trading at much higher fwd PE multiples when there were more question marks about the business model (mid 2018). I think the recent crash is an excellent buying opportunity. There is risk involved due to the lack of a moat, but the potential return of an investment is insane so its a speculative strong buy for me

Long MED

[EE Investing]

@HardytheTrader Yeah, totally agree. I don't think it can stay at such low levels for long.

[Senopta]

I am invested and like the dividend yield. However I really doubt they have a moat :)
1) people live healthier
2) if they are real good coaches, clients will have reached their goal after some time and quit because they had success and have learnt how to eat and live in a healthy way
3) more and more coaches are providing their knowledge much cheaper. social media is also a direct easy source in order to find reliable and suitable coaches.

I hope that MED performance well over the years, but at the moment I doubt it.

[EE Investing]

@Senopta Thanks for your comment!
These points don't address the moat that I explained in the article, but I think anyways you might be a bit too pessimistic here.

1) People wanting to live healthier, is great for the company
2) That is one possible scenario. It could also be that they get used to the food and will continue buying it or they see it as the reason for their diet's success and will keep buying it. Or they might become coaches themselves. It is difficult to estimate how many customers will stop being customers after a successful diet, but certainly, the number of people who stopped buying the products was much smaller than the number of people who started buying the products in the recent three years.
3) For sure, free consulting via youtube etc. is competition, but that is not a new thing. Those influencers have been there for a long time and it didn't stop the growth.

That being said, good luck with your investment!

[Sensible Investing]

@Senopta The MLM is the moat; I'd encourage you do some research as to what % of people who lose weight actually keep it off, despite how good the coach is - ever wonder why movie stars get fat afer the movie? Surely they can afford the best coaches??

[Senopta]

@Sensible Investing then they have learnt nothing or still have no discipline without a coach. It is simple physics.

[dc_dwd]

Margins under pressure due to inflation in short term as stated in the previous conference call is really my only concern. Looks like the sell off is happening throughout the industry and the chart looks.. well, ugly. Cyclicals is the play right now, so there is probably some rotation out of MED. I opened a position today because the fundamentals are too ridiculous to ignore and I like their business model.

Thanks for the analysis. It was a good read, and glad to that others think the same about MED.

[EE Investing]

@Daniel Casso Thanks for your comment!You are absolutely right, inflation will put pressure on the margins, but this will be just in the short term. Latest in twelve months from now, sales prices have been adjusted accordingly and margins will be back to normal.

[P373R]

Very nice write up.
My 2021/22 blended P/E (21 eps=13.9, 22 eps=16.9, P/E=18) fair value is $291 right now, not too far off from yours :)